hedging real-estate risk.pdf

Property Derivatives for Managing European Real-Estate Risk Frank J. Fabozzi is Professor in the Practice of Finance, Yale School of Management, New Haven, CT frank.fabozzi@ Robert J. Shiller is Arthur M. Okun Professor of Economics, Yale University, New Haven, CT robert.shiller@ Radu Tunaru is Senior Lecturer in Financial Mathematics, Cass Business School, City University, London r.tunaru@city.ac.uk 1 Property Derivatives for Managing European Real-Estate Risk Abstract Although property markets represent a large proportion of total wealth in developed countries, the real-estate derivatives markets are still lagging behind in volume of trading and liquidity. Over the last few years there has been increased activity in developing derivative instruments that can be utilised by asset managers . In this paper, we discuss the problems encountered when using property derivatives for managing European real-estate risk. We also consider a special class of structured interest rate swaps that have embedded real -estate risk and propose a more efficient way to tailor these swaps. Keywords : real-estate markets, property derivatives, balance guaranteed swaps JEL classification: G15, G20 2 1. Introduction The property market represents the largest market in developed countries in Europe and the world, estimated between 30% and 40% of the value of all the underlying physical capital. From a theoretical perspective, residential real-estate assets are viewed as a combination of a consumption asset and a leveraged investment. A decade ago Shiller and Weiss (1999) pointed out that this very characteristic